ICOs as a Funding Mechanism: Can it Work for You?

Until late 2017 and the earlier part of 2018, ICOs have been considered a kind of brave new world, an unregulated, uncharted wild west rife with both unknown risk and untapped opportunity.

Nothing excites the imagination like an uncharted landscape, and in the later part of last year, prospective investors rushed in.

By December, ICOs had raised more than six billion dollars and ICO funding had surpassed that of angel and early stage VC funding combined.

But uncharted landscapes don’t stay uncharted or unregulated forever. As startups and established companies increasingly turn to ICOs as funding mechanisms, regulatory agencies are subjecting ICOs to serious scrutiny.

Both the SEC and the CFTC are hard at work now regulating cryptocurrencies and token offerings, and also looking at ways to hold errant ICOs accountable, particularly under securities laws. Some jurisdictions are also looking for ways to outlaw fundraising through ICOs and are requiring already-raised funds to be returned to investors.

In the US, (as in some other jurisdictions) regulatory requirements apply to anything that can be offered and sold as a “security”, though some ICOs have attempted to skirt this definition by offering their tokens as so-called “utility tokens”, or consumptive tokens. The definition of security remains circumstantial and nuanced, but in general, it depends on how the tokens are marketed and whether or not they are presented as an item that will increase in value or can be used in secondary market trading. The SEC has recently taken the position that in its view, there are very few token offerings (if any) that are legitimate utility tokens.

We are working with several clients to make sure their token offerings and/or business models that rely on token offerings are compliant from a securities perspective as well as from a CFTC perspective. The days when you could just issue a bunch of securities to accredited investors is rapidly coming to an end. And our guess is that the SEC may require disgorgement by those companies that did those illegal ICOs.

The takeaway message: If you’re considering investing in or issuing an ICO, you’ll need to have a sense of the regulatory requirements that can affect your plans. And these regulations are more likely to apply if your chosen token can be considered an investment vehicle rather than a form of currency designed to be spent. Show caution and consider the legal implications if you can answer yes to any of these questions:

Does your coin give the holder a right to share in the profits or capital drawn from your project?

Do you expect that people will be buying the coins because they will increase in value over time?

Does your coin hold value based on another asset, like a commodity, a currency, or an underlying index?

Tokens that operate as true utilities are generally safer from regulatory restrictions and requirements, but once a coin can be described or presented as an investment vehicle, due diligence will require a closer look. Seek legal guidance before putting your trust and the future of your growing company in the hands of an ICO. Feel free to contact us if you have further questions.